The credit crunch hit close to home this summer when the University informed nearly 3,000 graduate students that it had lost its major lending partner and could no longer offer student loans.

Since 1996 the University had offered certain types of federally backed loans directly to graduate students as part of the School-As-Lender program. The loans were then sold for profit to the Illinois Designated Assistance Purchase Program (IDAPP), a state chartered organization.

Unlike regular private loans, obtained through a bank or other lender, the loans made by the University have no upfront costs and give students breaks on interest rates for on-time payments. However, tightening credit conditions have made it difficult for IDAPP to renew its credit line with a major commercial bank, and it could no longer guarantee that it would be able to purchase the University’s loans. With no partner in place, the University decided to pull out of the program altogether.

Students were notified of the change by email July 2 and were advised to start looking for private lenders. According to University Bursar Michael Kocelko, University administrators had high hopes that the program would continue just weeks before it fell through.

The University provided a list of preferred lenders and offered cash advances to cover expenses for students who might be unable to secure funding in time for the beginning of the school year.

According to Kocelko, most students remained relatively unaffected by the change. “No one had any challenges supporting their educational needs. It didn’t create any hardship other than having to take the time to find another lender,” he said, attributing that to U of C students’ generally good credit scores.

One group of students may be disproportionately affected. International applicants often lack the credit references necessary to obtain loans from increasingly wary banks. To help address some of these problems, the University is helping to fund a guaranteed loan scheme through Citibank, available for first and second year MBA students.

University of Chicago students are not the only ones facing new challenges in securing funding this year. There were over 150 participants in the School-As-150 participants in the School-As-Lender program, but many are expected to pull out this year. The Illinois Institute of Technology, another school that partnered with IDAPP, has suspended its program temporarily.

On an even larger scale, the Massachusetts Educational Finance Authority, a provider of student loans in Massachusetts, announced last spring that it too would stop offering federal student loans. The non-profit lender had about $300 million in federal loans on its books and had leant to 14,700 students in the last school year.

Hoping to preempt another lending crisis, the U.S. government has taken steps to prop up the market for student loans. The Ensuring Continued Access to Student Loans Act of 2008, passed in May, allows the Education Department to purchase federally backed loans from primary lenders. The government’s promise could give lenders the confidence to continue lending to students without fear that they will not be able to unload them. The bill also improves the terms of federally backed loans, which could make them a viable option for more students.

On September 8, the state of Illinois announced that it had secured $100 million from several major credit unions and state agencies that would allow it to fill part of the funding gap by offering government-backed Stafford loans.

But the credit crisis may be the final nail in the coffin for the School-As-Lender program. Interest in the program began to cool even before the credit crisis, due to concerns that it gives schools an improper incentive for students to take on debt. A 2005 law required that schools must use any profits from the program to fund need-based financial aid programs, but Congress has continued to limit new schools entering the program and the types of loans it covers. Yale and Duke Universities, the University of Pennsylvania, and others have already withdrawn from the program.